What You Actually Need to Know About Credit Cards and Credit Scores
Swiping a physical credit card or tapping to pay with your phone feels effortless, giving the illusion that your spending has no limit. While a debit card instantly pulls money from your own checking account, each time you pay with a credit card, you are instantly borrowing money from the bank. Money you have to pay back. Using a credit card responsibly can build you a good financial reputation but using it irresponsibly may lead you into debt.
A credit card does not charge you the second you buy something. Rather, it opens something called a billing cycle. The bank keeps track of everything you purchase during a given cycle. At the end of the cycle, which lasts about 30 days, you receive a bank statement, listing everything bought in your account and how much it cost. Upon receiving this statement, there are three crucial numbers that you must pay attention to: The Statement balance, (the total of everything you spent during the 30-day cycle) the Due Date, (the absolute latest time you can transfer the money from your checking account to your credit card account) and the Minimum payment (the smallest amount of money you can pay without getting in trouble.) If you pay the entire statement balance before the due date, there is no interest but if you pay the minimum, the remaining cost rolls over to the next month and you are charged with interest ranging from 18% to over 28%. Unpaid interest gets added back to your balance for the next month, so you end up paying interest on top of last cycle’s interest.
If interest rates are so high, why would anyone risk going into credit card debt, why not just get a debit card? One reason is because your money is safer from fraud. If a debit card number gets stolen, the money is stolen directly from the owner’s savings whereas if a credit cardholder’s account is hacked, the bank’s money is being taken. Legally, the bank is held accountable for the fake charges, not the cardholder.
When trying to take out a loan or open a new card, the bank will check your credit score, a three-digit number, usually ranging from 300 to 850. The higher your score, the more financially trustworthy you are seen as. Your credit score is based on many factors. Most critically, your Payment History which accounts for 35% of your credit score. It shows whether you pay your bills on time. 30% of your score is dependent on your Credit Utilization. This means you shouldn’t max out your cards and you should be spending well under your card limit. In addition, the Length of Credit History is 15% of your credit score. The scoring system rewards you for keeping your old accounts active, which proves you can be a reliable borrower over a span of several years. Another 10% is your Credit Mix, the variety of accounts you have. Banks want you to have experience managing different types of borrowing at the same time, rather than just knowing how to pay one card’s bills. Although it looks good to have a credit mix, banks expect young people to have a “thin file.” The remaining 10% of your credit score belongs to New Credit Applications, which is how frequently you request to borrow money. Applying for multiple cards or loans in a short timeframe will temporarily lower your score.
Federal law states that no one can open their own credit card account before they turn 18. If you are between the ages of 18 and 21, you either need proof of a steady income or an adult co-signer who agrees to pay off your debt if you fail to do so. Even if you are below 18, you can start building your credit score if your legal guardian adds you as an “authorized user” on their credit card. The bank sends a card with your name on it, but your guardian is legally responsible for the bill. The benefit is that every time your parents pay their bill on time, that positive payment history gets copied onto your new credit report, giving you a good financial reputation before you even turn 18.
When you are trying to take out your first card, most credit cards will likely reject you because you have no financial track record. You still have options though: The first is a student credit card, which is specifically designed for college students and comes with a very low credit limit. The second is a secured credit card. With a secured card, you have to give the bank a cash deposit upfront. If you give the bank $200, your credit limit is exactly $200. This protects the bank completely while allowing you to prove you can handle monthly payments. One of the safest ways to build up your credit score without risking going into debt is to use your card to pay for one subscription, such as Spotify or Netflix. You would set up your bank app to automatically pay that subscription cost in full every month and not use the card for anything else. This method is low risk while keeping your card active.
It is crucial that everyone considering ever taking out a credit card understands that paying with that card is borrowing money that needs to be repaid. While there is always a risk of hurting your credit score, credit cards are beneficial for a variety of reasons.
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